B.I.G. News: 5-Year Recognition Period for Built-In Gains Tax

March 21, 2016 | Matt Stelzman

Conversion from C-Corporation (C-Corp) to S-Corporation (S-Corp) is often worth pursuing for taxation purposes. C-Corps are taxed at the corporate level as well as on any dividends the shareholder(s) receive. In the case of an S-Corp, taxes are not assessed at the corporate level, allowing more revenue to flow to the shareholders.

That sounds good, but there’s a potential cost – the Built-In Gains (BIG) tax.


big tax waiting


When a C-Corp converts to S-Corp status and sells its assets, BIG tax is incurred. The tax is based on the fair market value of the corporation’s assets less any tax basis inherent in them as of the conversion date. Built-in gains are only taxed if the new S-Corp sells any of the assets included in the conversion during a “recognition period.” This is to prevent C-Corps from converting to S-Corps just prior to a sale in an effort to avoid taxes.

From 1986 through 2008, the built-in gains recognition period was 10 years. However, from 2009 through 2014, Congress temporarily reduced the recognition period to between five and seven years. The reduction’s temporary basis made it difficult for any recently converted S-Corp to appropriately plan for the sale of the business.


big tax handshake


Here’s the good news: the recent Protecting Americans from Tax Hikes Act (PATH) made the five-year recognition period permanent for S-Corps. Recently converted businesses – or those thinking of converting now – can benefit from this regulatory improvement.

For example, say an S-Corp receives a valuation including $20 million in built-in gains. The BIG tax on those gains would be $7 million. But now, instead of waiting 10 years to sell, the business owner simply needs to build the value of the company for 5 more years – and then sell without losing that $7 million.

That’s BIG news.